Assignment 2



Assignment 2Gemma Purse | CQUniversitySTEP 7:According to their website Philips has thousands of trademarked and patented products, many of which they sell and produce worldwide. For the purposes of this assignment I have chosen three products that are all for personal use in domestic environments, these products are:Philips 18-in-1 Multigroom Trimmer: suggested retail price $189/€116Sonicare DiamondClean Smart Sonic electric toothbrush; suggested retail price $429/€263Philips Airfryer XXL: suggested retail price $488/€299I found these products listed on the Philips Australia website in AUD prices, so my first step was to change the price to Euro as that’s the currency of my financial statement figures. Next, I had to think about what variable costs would be associated with these types of products and came to the decision that they probably wouldn’t take much in price of materials or time, as consumer electronics have a reputation of being relatively inexpensive to produce. So I chose to set variable cost at 55-65% of the recommended retail price (rounded to the closest dollar for simplicity), with the variable cost of the razor 60% because it isn’t material heavy but has many fiddly moving parts, the Electric toothbrush at 55% as it is classified as a ‘smart’ product and is slightly more technologically advanced but is still a higher volume product, and the fryer towards the higher variable cost range at 65% because they wouldn’t cost much material wise but would have to meet higher safety standards and would depend on higher sales volumes to break even. This decision was influenced by the fact that on average costs of goods sold is about half the amount of sales revenue for Philips and they would have a range of products that are relatively expensive to produce, whereas the ones I chose would sit more towards the middle to lower end of the price scale. With the sales price taken directly from the Philips website and the variable cost calculated as a percentage calculating the contribution margin for each product is easy, it’s only a simple formula (Sales price – Variable cost = Contribution margin) that has important implications and is useful to know when calculating how many units to produce for sale to reach a profitable figure. The contribution margins for my 3 chosen products, the trimmer, toothbrush and Airfryer, are €46, €118, and €105 respectively; this is the amount per individual product sold (of each) can be contributed towards paying fixed costs of the business, with any remaining funds contributing directly to profit.Multigroom TrimmerElectric ToothbrushAirfryer XXLSales Price€116€263€299Variable Cost€70€145€194Contribution Margin€46€118€105Contribution Margin Ratio0.40.450.35Ideally a firm would have a range of products to offer choice and reach a broader market and maximize profit, and most would have different contribution margins. The contribution margin would differ between products as the price of manufacturing and selling would vary from product to product. I also wanted to reflect this variance with the profit margin percentages I chose, to better demonstrate the how they would be in real life. As Philips is a multinational company competing in multiple industries, they would face a larger variety of constraints than a local company that only produced products in one industry. The health industry itself would have varying rules and regulations depending on the country that would dictate the type of products able to be sold and strict health and safety measures that would have to be met. The products I have chosen are all electronics; to sell these in different countries they would have to meet the regulations of that country, and then the inner components would have to be altered depending on what country the product is being produced for, as different countries have different power adaptors and voltages. Availability and where the product could be purchased, would also be a constraint to consider. While the Multigroom trimmer and the airfryer are both available for purchase in multiple stores, including big chains like JB-HI-FI, Myer, Harvey Norman and David Jones, the Sonicare electric toothbrush is only available through the shaver shop, limiting exposure to customers and the overall number that could have been sold had it been available elsewhere. STEP 8:I was a bit anxious entering step 8 because I thought it would be the most difficult step in the unit, but it was actually a lot simpler than I had thought it would be. Calculating ratios was straightforward because all the instructions are in the calculations themselves, you just need to find the corresponding total in the financial statements. The hardest part of this step was to take the figure given by the calculation and make sense of what it was trying to convey about Philips.Profitability Ratios The purpose of profitability ratios is to illustrate how effectively your business is turning activities into profits. The net profit margin ratio (NPM) tells us that, for each dollar of sales, how much is profit. For Philips this figure sits at a steady rate with a slight dip in 2017 which was not a good year for them and in which they sold off discontinued assets (Philips Lighting). Likewise, the return on assets (ROA) tells us how much profit a business is making for each dollar of assets the own, basically how well they are turning assets into profit and whether they are using them efficiently and effectively. ROA for Philips is a steady 5%, so they are getting a constant return on assets even though the amount of assets owned by the business has decreased, this just mean that they decreased their assets that weren’t being used efficiently, or they decreased their total assets and started using the remaining assets more efficiently. The picture presented by the profitability ratios of Philips is that, though it is only a small percentage, Philips is effectively managing their business activities and assets to generate profit.Efficiency RatiosEfficiency ratios measure the firm’s ability to manage assets and cover liabilities in the short run. The days of inventory ratio tells us the average number of days it takes to sell its inventory, or on average, how long inventory waits around before being sold and turning a profit. For Philips, inventory turnover averages at over 100 days, though in 2017 this was down at only 90 days due to less inventories being sold at a higher cost to the business relative to other years, though I don’t know why this would be. I think the turnover rate for Philips makes sense for the industry they are in; health technology would probably be purchased by consumers infrequently, Philips would have to hold big ticket items like MRI machines in stock, but the frequency of demand would be low, and they would have to cover this with a few smaller faster selling items. Total asset turnover tells how effectively assets are used by the firm to generate sales. In 2018 Philips has a high total asset turnover of 70% meaning that for every dollar of assets owned they generate 70c for the business, this is a 30% increase from 2016 and looks to be a constant figure as it was the same in 2016 and 2015, increased in 2017 when they sold Signify (reducing assets but maintaining sales). Liquidity RatiosThe liquidity of a business is its ability to pay its debt. Current ratio is basically how well a company could pay off its short-term debts and obligations through the collection of its current assets. The current ratio for Philips is greater than 1 every year, meaning they have working capital from their current assets to potentially pay off their entire short-term liabilities. This figure is highest in 2017 because they had a lot less short-term debt, which could be attributed to the sale of signify and them using the received funds to pay off some of their short-term debts. Financial Structure RatiosThe purpose of financial structure ratios is to give an indication as to how the business receives outside funds and the balance of where those funds come from, whether this is through outside sources (liabilities) or funded through equity investors. Debt/Equity ratios shows the percentage of debt to equity, this shows how this business is funded, and how many funds are from outside sources against each dollar that shareholders invest into the firm. The financial statements for Philips show an improvement in the debt to equity ratio, in 2015 for every dollar contributed by shareholders the business got 1.64 from outside sources, whereas in 2018 the ratio decreased to 1 dollar to every 1.21. This can be attributed to a steady decrease in non-current liabilities and a slight increase in equity, meaning the business is slowly paying off their long-term debts. The Equity ratio shows what percentage of assets have been funded through equity investors and is an indicator of how much of a business is funded through equity as apposed to outside sources. The equity ratio of Philips has been improving since 2015 starting at 38% and increasing to 47% in 2018, meaning they have gone from being 62% funded by liabilities to only 53%, which is still a high percentage.Market RatiosEarnings per share (EPS) is the net profit (after tax) divided by the number of shares issued by a company, this ratio shows how much the business is earning per share and is an indicator of the market profitability. For Philips shares issued seems to be downward trending with an outlier in 2017 when they would have issued more shares to cover for the sale of Signify, earnings per share is also less then the market price per share meaning each share is earning less than it is worth on the market. Dividends per share (DPS) is the dividend amount the company paid out to shareholders per share and is steadily growing. Price earnings ratio is an important figure to investors, as it tells them how long it would take to recoup any initial investments and start seeing profit. The price earnings ratio of 2018 means that if you were to buy a single share it would take 25 years to start seeing profits with all else remaining constant. Restated RatiosReturn on equity (ROE) shows how the percentage of profit returned on equity after tax, in other words how much every dollar of equity earned for the business. For Philips this is a pretty promising figure at 10-12%, compared to some of the company’s other students got, with many of the ones I saw having either negative values or below 5%. Separating operating and financial activities of the business saw to a 5-7% increase in the return on net operating assets (RNOA) when compared to the return on assets (ROA), meaning that operating assets are being used efficiently. Net borrowing cost (NBC) is used to indicate the interest a business pays on borrowings. NBC for Philips is unusually high and increased by 7% from 2015 to 2018, meaning that though this period saw a decrease in financial expenses and net financial obligations the ratio between them has increased. Profit margin (PM) took a hit in 2017 because of a large loss in currency translation difference which is usually a positive figure for Philips, this could have been incurred as part of the process of selling Signify or consolidating several assets back into the main company, however this is still an increase compared to net profit margin. Asset turnover for restated financial statements follows the same premise as the total asset turnover ratio except this ratio compares total sales against operating assets, not total assets, and gives a clearer picture as to how the business is their operating assets to generate profit. For Philips this figure shows the same rate of increase at a higher percentage meaning that the business is using operating assets efficiently to gain returns.Economic ProfitIn simplest terms economic profit is a firm’s ability to create or add value for its equity investors. It is calculated by taking the amount of sales that exceed opportunity costs and multiplying by the amount of resources the business uses to create products for sale. Unfortunately, after a quick search of Philips’ financial statements I couldn’t find the weighted-average/opportunity cost of capital (WACC) and had to use 10% as my figure, so I don’t know how accurate my economic profit is. That said using 10% for WACC gave me some interesting figures to analyze and some clue into how important a proper weighted average is when calculating economic profit. In my ratio calculations Philips is earning economic profit each year that coincides with comprehensive income earned that year. However, in 2017 economic profit is at a loss and significantly lower than the previous year, but by changing the WACC by 3% (down to 7%) suddenly they are generating a profit. This just highlights the importance of knowing the WACC, and also a bit of insight as to why many companies don’t provide it (or make it easy to find), as without this knowledge you can only speculate and make assumptions. STEP 9:I did a few searches through my financial statements and online to figure if Philips is currently facing any capital investment decisions and whether there were any decisions made in recent years that could serve as inspiration for step 9 of this assignment and lo and behold, there were two situations that fit the bill.The first is a long-term partnership agreement struck with German hospital groups, where by Philips agreed to replacing and maintaining advanced medical equipment and in return for access to important medical research and state of the art facilities. The goal of the partnership is to increase quality and efficiency of care of patients and is stated to last 8 years, at which point both parties will decide whether to continue the partnership or disband. The project will cost an estimated value of $50 million euro.The second capital investment decision is that in the beginning of 2019, Philips were having discussions about expanding production in the Egyptian market. Philips wish to expand into the Egyptian market by opening a production facility to create local jobs and to reduce sales costs in Egypt by taking advantage of trade deals Egypt has with surrounding countries. They have the ambitious aim to increase their market hold in Egypt to 15% and wish to inspire product loyalty in local communities by providing innovative support programs and partnering with local hospitals. To make both of these projects easier to compare there are a few guidelines I created for myself in when deciding on the figures and timeframes for these investment decisions. Because these are fake scenarios, I decided to pretend that they were occurring at the same time. Since the German group decision will cost an estimated €50 million euro and last for 8 years, I have decided that Philips has limited funds to spend and they can either sign a supply and research agreement with the German groups OR expand their production in Egypt by opening a new factory, with an 8 year timeframe to see which is the better option. For investment decision 1; even though it is an agreement to provide ongoing maintenance, replacements and updates, I decided that they would treat the €50 million as a loan amount they need to repay before making profit which would be generated through the sales and production of products they would be creating with access to advanced medical research gained through the agreement. Because research takes time, I guessed that cash flow in the first 2 years would be lower and then take off when products from the agreement are released. I am also assuming that when the agreement ends both parties will go their separate ways, with Phillips selling any machinery left on hospital premises to the hospital, I estimate the price of this machinery to be about €5 million.For investment decision 2; Philips would be buying a factory space and equipping it with machinery, I estimate that this would cost about 30 million, and they would be purchasing an existing factory and reequipping it for their purposes. At the end of 8 years it can be assumed that the factory in Egypt would remain open as it provides Philips with a gateway into the markets of surrounding countries. The original cost, estimated life, residual value and estimate future cash flows of each investment are set out in the table below. Calculations assume a rate of return/ weighted average cost of capital (WACC) of 10 %. All amounts are expressed in Euro.German Hospital GroupsEgyptian ExpansionOriginal Cost€50 Million€80 MillionEstimated Useful Life8 Years8 YearsResidual Value€10 Million€20 MillionEstimated future cash flowsYear 0-€50 M-€80 MYear 1-€10 M-€4 MYear 2-€1 M€1 MYear 3€5 M €7 MYear 4€9 M€15 MYear 5 €15 M€20 MYear 6€20 M€27 MYear 7 €25 M€30 MYear 8€40 M€50 MSummaryGerman Hospital GroupsEgyptian ExpansionOriginal Cost€50 Million€80 MillionEstimated Life8 years8 yearsPayback Period6 years, 175 days6 years, 170 daysNet Present Value€2.08-€0.93Internal Rate of Return10.6%9.8%Payback period tells the amount of time it takes for a firm to cover the initial cost of an investment before they can start accumulating revenue. There is only a difference of five days between these two capital investments and both are due to break even and start producing profit around the 6-and-a-half-year mark, the similar time frame also means time will not be a huge contributing factor to the decision Present Value (NPV), which is used to determine how much value will be generated by an asset, also removes any possible inflation and turns estimated future cash flows into current day prices. This calculation actually made my investment decision easy as it removed the Egyptian expansion option from the table because the estimated value of NPV for option 2 is a negative figure and therefor would not be recommended as an option as it means that they would be running at a loss. Option 1 is still viable however and has an NPV of €2.08 (Million). Internal rate of return (IRR) is the last figure needed when making this kind of decision and is a bit complicated to understand. The way I understand it is that it is the expected rate of return from a project, or the rate needed for NPV to break even. IRR serves as a measurement of risk, a higher percentage means more risk while a lower one means lower risk, however if IRR is lower than WACC than you shouldn’t accept that option because the risk and return are not high enough. If NPV didn’t knock option 2 out of consideration, the IRR for it would have as it is below the WACC percentage, while option one is safe, just crossing the line at 10.6%.In conclusion, while both options sounded promising to begin with, having done the calculations I can now see that only option 1, the agreement with the German health group, will turn a profit for the business. I actually liked this option more to begin with, as the aim is to help others and improve lives through research and development, whereas the other option was just an expansion into new territory that did not benefit as many people.STEP 10:Throughout this course I found that the feedback from other students was the most helpful aspect of each assignment. I loved the fact that we all had different companies so that we could compare our spreadsheets and companies and help one another when in need of help. That said, due to my own lack of organization and time constraints out of my control, I was unable to post my draft for feedback until after everyone else completed their mad dash to the finish of their assignments and as this was the last piece of assessment no one appears to have lingered to help the students who were unable to meet the assignment deadline or who had pleted Feedback SheetsFeedback From: Gemma PurseFeedback To: Kayla Wittwer(Provided on Moodle Forum)My CommentsStep 7Identify three products or services of your firmEstimate selling price, variable cost & CMCommentary – contribution marginsConstraints – identify & commentaryGood job. I like the fact that you chose from a wide range of services instead of 3 from the same area or product line. You did a good at estimating the prices of your products and you even went the extra mile to track down and calculate wages instead of guessing at a figure and calling it a day. Your logicand reasoning is sound, and you explained every thought process behind this step really well. All you’re really missing is some kind of introduction or some linking sentences to tieit all together as at the moment you have 3 orphaned pages with no flow, that are semi related to each other; maybe try to compare your products against each other. Step 8Calculation of ratiosRatios – commentary (blog)Calculate economic profitCommentary – drivers of economic profit (blog)Step 9 Develop capital investment decision for your firmCalculation of payback period, NPV & IRRRecommendation & discussionOverall ASS#2 Steps 7-9Feedback From: Gemma PurseFeedback To: (Provided on Moodle Forum) ................
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